Flood of Dollar Deposits Drives India Bank Liquidity Surplus to All-Time Peak

India’s banking system liquidity surplus has jumped to a record high, with rupee liquidity surpassing levels witnessed in the aftermath of Covid-19, as lenders collected more dollars than expected under the central bank’s deposit scheme.

Bank liquidity surplus stood at 9.7 trillion rupees ($102.67 billion) as of September 3, the highest ever recorded surplus, surpassing the 9.2 trillion rupees registered in September 2021.

Indian banks raised $127.23 billion through non-resident foreign-currency deposits announced by the Reserve Bank of India, and most of the amount has already been swapped with the central bank resulting in a sharp spike in rupee liquidity.

The surplus complicates the RBI’s job of managing liquidity and overnight rates, with Nomura noting that the RBI is facing a problem of plenty.

“While some of the surplus...will be offset by higher cash in circulation during the upcoming festive season, maturity of forwards, and due to any potential RBI FX intervention, the RBI may have to employ a panoply of liquidity absorption tools to mop up this surplus,” Nomura economists Sonal Varma and Aurodeep Nandi said in a note.

The unprecedented liquidity surplus comes as the Reserve Bank of India (RBI) continues to balance its efforts to support economic activity with the need to keep short-term money market conditions stable. The excess funds have the potential to push overnight rates lower if they are not absorbed through the central bank’s liquidity management operations.

For commercial banks, abundant liquidity could improve lending conditions by providing greater scope to deploy funds into loans and other assets. It may also ease funding costs and support credit growth, although a prolonged surplus could put downward pressure on short-term market rates and complicate the transmission of the RBI’s monetary policy stance.

The RBI is therefore expected to closely calibrate its liquidity operations in the weeks ahead, using a combination of instruments to absorb excess funds when necessary. Seasonal currency demand, foreign exchange operations and the maturity of forward positions will also influence the level of surplus liquidity as the central bank seeks to maintain orderly conditions in financial markets.